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How A Corporate Watchdog Nearly Lost Its Bite

May 19, 1996

Economic Viewpoint

HOW A CORPORATE WATCHDOG NEARLY LOST ITS BITE

A newly assertive Securities & Exchange Commission is trying to save the Financial Accounting Standards Board from a power play by large corporations and banks seeking more latitude for creative ac- counting. At stake is not only FASB's integrity and independence but also investor confidence that accountants and their clients aren't colluding to cook corporate books--in short, the efficiency of capital markets.

The story is also significant for what it reveals about the limits of self-regulation. FASB was created in 1973 as the officially recognized body in charge of accounting standards, responsible to a nonprofit Financial Accounting Foundation. The SEC is empowered by law to set corporate accounting standards. But since 1936, the commission has delegated that job to private bodies affiliated with the accounting profession, mostly with happy results--until now.

For its first two decades, FASB enjoyed a well-deserved reputation as an independent body committed to the public interest. The main criticism was that it took too long writing new standards. In recent months, however, trustees of the foundation nominally in charge of FASB have campaigned to clip its wings. This campaign is advertised as an effort to streamline FASB, but the reality is that key business and banking leaders are opposed to the degree of disclosure FASB champions.

WIGGLE ROOM. What could have business so annoyed? For one thing, FASB is working on a new standard requiring derivative securities to be counted at present market value--not their issue price. At present, accounting practices for derivatives and hedging exposures are a hodgepodge, allowing corporations and banks to hide potential losses. For another, beginning in 1993, FASB has sought clearer accounting of executive stock options. In the face of furious opposition, it backed down in October, 1995, and issued a disclosure standard with lots of wiggle room.

The board of the Financial Accounting Foundation, which governs FASB, is the corporate power elite in cameo. Its trustees include the chief financial officers of General Electric, Microsoft, Citicorp, and Morgan Stanley, as well as executives of major accounting firms. The sole "public-interest" representative is currently Kathryn D. Wriston, wife of Walter B. Wriston, the retired Citicorp chairman. Even worse, FASB depends on the same foundation board to raise much of its operating budget, which sets up an exquisite conflict of interest in which the industries affected by FASB rulings raise its money.

The most recent attack on FASB independence has been led by J. Michael Cook, the foundation's president and CEO of Deloitte & Touche, the Big Six accounting firm. Cook began the skirmish with a letter last February proposing to rein in FASB by reducing its agenda-setting powers. This followed a demand last November by the 14,000-member Financial Executives Institute, a lobbying group, for increased business influence on the standards-setting process. The lobbying group accused FASB of "an implicit antibusiness bias."

CIVILIAN REPS. In April, SEC Chairman Arthur Levitt Jr. weighed in, declaring that what FASB needed was more independence from business pressure, not less. In a public speech to the Economic Club of Chicago and in follow-up discussions with Cook, Levitt asked FASB trustees to restructure their board to produce a majority of public-interest members, with SEC involvement in the selection process. As a last resort, the SEC could take away the existing trustees' jurisdiction over FASB or even reclaim control of the standard-setting process.

Levitt says he would prefer to keep FASB as an independent body, but that "quasi-public bodies like FASB should look, smell, and feel like the public that they are mandated to represent." Levitt wants a governing body of public figures and representatives of the investor community committed to FASB's operating independence. At this juncture, the SEC chairman and the trustees still have major differences on whether a representative of an industry affected by FASB decisions can be considedred a "public" trustee of its governing body.

The attack on FASB's independence has been blunted, for now. But this episode shows the brazenness of leading segments of the corporate and banking community seeking latitude to mislead investors. It has been a long slide since the original trustees reliably defended FASB's independence. The affair also suggests that FASB, as a quasi-public body, should get its appropriations directly from the Treasury Dept. Finally, the attack on FASB is a reminder that self-regulation is only as good as the public regulation that stands behind it.BY ROBERT KUTTNER